Ichimoku Cloud trading strategy

The Ichimoku Cloud is a technical analysis tool that could be used by traders to help identify support and resistance levels, trend direction and momentum.

Highlights

The Ichimoku Cloud features multiple elements represented by different indicators. It was created by the Japanese journalist Goichi Hosoda in the 1930s but was not published until 1969. 

It comprises five lines each representing an overview of the price and a shaded area called the Ichimoku Cloud. According to the Ichimoku Cloud strategy, if a price is above the cloud, that suggests a rising trend, while if it is below the cloud, then it represents a falling one. If it is inside the cloud, then that indicates a flat market.

Below we take a look at what the Ichimoku Cloud is, what it does, how it works and how it could potentially help traders create an Ichimoku strategy.

Components of the Ichimoku Cloud

There are five different parts of the Ichimoku Cloud. Knowing about them is helpful when it comes to Ichimoku trading or trying to form an Ichimoku trading strategy. 

• Tenkan-Sen (Conversion line)

This is the shorter of the two baseline components of the Ichimoku indicator. It is calculated by taking the average of the highest high and the lowest low over the past nine periods. The line is used to indicate short-term momentum, and can be used as a support or resistance level. 

When the Tenkan-Sen crosses above the Kijun-Sen, it is considered a bullish signal, and when it crosses below the Kijun-Sen, it is considered a bearish signal.

• Kijun-Sen (Base line)

The Kijun-Sen is the longer baseline component. It is calculated by taking the average of the highest high and the lowest low over the past 26 periods. The line is used to indicate medium-term momentum, and can also be used as a support or resistance level. 

When the price is above the Kijun-Sen, it is considered a bullish signal, and when it is below the Kijun-Sen, it is considered a bearish signal.

• Senkou Span A (Leading Span A)

The Senkou Span A is one of the two components of the Cloud itself. It is calculated by taking the average of the Tenkan-Sen and the Kijun-Sen, and plotting the result 26 periods ahead. This line is used to indicate the current trend and support and resistance levels in the medium term. 

When the price is above the Senkou Span A, it can be interpreted as a bullish signal, and when it is below the Senkou Span A, it is considered a bearish signal.

• Senkou Span B (Leading Span B)

The Senkou Span B is the second component of the Cloud itself. It is calculated by taking the average of the highest high and the lowest low over the past 52 periods, and plotting the result 26 periods ahead. This line is also used to indicate the current trend and support and resistance levels in the medium term.

When the price is above the Senkou Span B, it is considered a strong bullish signal, and when it is below the Senkou Span B, it is seen as a strong bearish signal.

• Chikou Span (Lagging Span)

The Chikou Span is the final component of the Ichimoku Cloud, and is plotted 26 periods behind the current price. This line is used to confirm trends and support and resistance levels, as well as to provide a trading signal. When the Chikou Span crosses above the price, it is considered a bullish signal, and when it crosses below the price, it is considered a bearish signal.

Ichimoku Cloud trading signals

Ichimoku Cloud signals may be used to identify potential entry and exit points, as well as to determine the overall trend of the market. 

Here are some of the key trading signals generated by the Ichimoku Cloud:

• Bullish and bearish signals. When the price of an asset is above the Cloud, it could be seen as a bullish signal. Conversely, when the price is below it, it could be considered to be bearish. These signals could be used to identify the overall trend of the market and to make trading decisions accordingly.

• Tenkan-Sen and Kijun-Sen crossovers. When the Tenkan-Sen crosses above the Kijun-Sen, it is considered a bullish signal, and when the Tenkan-Sen drops below the Kijun-Sen, it is seen as bearish. These crossovers can be used to identify potential entry and exit points.

• Senkou Span crossovers.  When the Senkou Span A crosses above the Senkou Span B, it is considered a bullish signal, and when the Senkou Span A crosses below the Senkou Span B, it is a bearish one. These crossovers can also be used to identify potential entry and exit points.

Ichimoku Cloud trading strategies

There are several different trading strategies that could work with the Ichimoku Cloud.

Trend-following strategy

By analysing the different components of the indicator, traders could identify the overall trend of the market and enter trades in the direction of that trend.

One common approach is to wait for a signal, such as a Tenkan-Sen/Kijun-Sen crossover or a Senkou Span A/Senkou Span B crossover, and then enter a trade in the direction of the trend. Traders could use other indicators, such as moving averages (MAs) or oscillators, to confirm signals and provide additional insight into market trends

Breakout strategy

Traders could look for breakouts above or below the Cloud, indicating a potential change in trend or a continuation of the current trend. 

The Chikou Span may be used to confirm breakouts, as it represents the current price in relation to the past one. Traders could enter a trade when the price rises above or falls below the Cloud, with stop-loss orders placed to limit potential losses. Although it should be noted that these orders do carry a risk of slippage, another option is guaranteed stop losses, which have no risk of slippage but have a premium fee.

By using the Ichimoku Cloud for breakout strategies, traders could potentially take advantage of sudden shifts in market sentiment.

Reversal strategy

Traders could look for signals that indicate a potential reversal in the trend, such as a Chikou Span cross above or below the price or a Kumo twist. These signals may be an indication of a shift in market sentiment and a potential reversal in the current trend.

Trading with the Ichimoku Cloud

Here are some factors that could potentially help traders with their Ichimoku Cloud usage. 

• Understanding the indicator. Before using the Ichimoku Cloud in, it is important to fully understand the indicator and its components. Traders could take some time to learn about the different parts and how they are calculated, as well as how they could be used to generate trading signals.

• Varying things. While the Ichimoku Cloud is a powerful indicator on its own, it is always beneficial to use it in combination with other technical indicators. This could help confirm signals and provide additional insight into market trends.

• Setting clear entry and exit points. When using Ichimoku Cloud to generate trading signals, it is important to set clear entry and exit points. 

• Practising proper risk management. Like any form of trading, Ichimoku Cloud trading involves risk. It is important to practise proper risk management techniques, such as using stop-loss orders or guaranteed stop-loss orders, which eliminate the risk of slippage but require a fee to be paid, and limiting exposure to any single trade.

Conclusion

In conclusion, the Ichimoku Cloud is used to help traders understand trends, momentum and support and resistance levels. It is relatively versatile, and traders could potentially use it to work out trends to follow, as well as looking for potential breakouts and reversals. 

However, like all trading strategies, the Ichimoku Cloud cannot predict the future and no Ichimoku strategy is entirely risk free. 

Traders should remember to do their own research, remember that markets can move against them at any time, and never trade with more money than they can afford to lose. 

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